Analysis and

Interpretation of
Financial Statements
1
 Financial statement (FS) Analysis
 is the process of evaluating risks, performance,
financial health, and future prospects of a business by
subjecting financial statement data to computational
and analytical techniques with the objective of making
economic decisions (White et.al 1998).T
 here are three kinds of FS analysis techniques:
 - Horizontal analysis
 - Vertical analysis
 - Financial ratios
 Horizontal analysis
-also called trend analysis, is a technique for
evaluating a series of financial statement data over a
period of time with the purpose of determining the
increase or decrease that has taken place
-uses financial statements of two or more periods
-behavior of the account over time(increasing,
decreasing or not moving)
-magnitude of the change
-the relative change in the balances of the account over
time
-Changes can be expressed in monetary value (peso)
and percentages
Peso change=BCY-BPY
Percentage change= (BCY-BPY)/ BPY
OR Peso Change/ BPY
 Vertical analysis
 also called common-size analysis, is a technique
that expresses each financial statement item as a
percentage of a base amount
For the SFP, the base amount is Total Assets.
Balance of Account / Total Assets.
From the common-size SFP, the analyst can infer
the composition of assets and the company’s
financing mix.
 The above may be evaluated as follows: The largest component of asset is
Equipment at 39.3%. Cash is the smallest component at 14%. On the other hand,
50% of assets are financed by debt and the other half is financed by equity.
 For the SCI, the base amount is Net Sales.•
Balance of Account / Total Sales.
• This will reveal how “Net Sales” is used up by
the various expenses.
• Net income as a percentage of sales is also
known as the net profit margin
EXERCISE
S
HORIZONTAL ANALYSIS
VERTICAL ANALYSIS
Provided below are the financial statements of FGHI Company Ltd. Your task is to compare
the profit performance and financial position of FGHI Company Ltd. with the average of the
industry. Prepare the common size financial statements and compare your results with the
industry average.
ASSIGNMENT
(BY PARTNER)
Analysis and
Interpretation of
Financial Statements
2
 Financial statement (FS) Analysis
 is the process of evaluating risks, performance,
financial health, and future prospects of a business by
subjecting financial statement data to computational
and analytical techniques with the objective of making
economic decisions (White et.al 1998).T
 here are three kinds of FS analysis techniques:
 - Horizontal analysis
 - Vertical analysis
 - Financial ratios
 Ratio analysis
 expresses the relationship among selected items
of financial statement data. The relationship is
expressed in terms of a percentage, a rate, or a
simple proportion This ratio is called asset
turnover. There are many ratios used in business.
 Financial ratio
 is composed of a numerator and a denominator.
For example, a ratio that divides sales by assets
will find the peso amount of sales generated by
every peso of asset invested. This is an important
ratio because it tells us the efficiency of invested
asset to create revenue.
These ratios are generally grouped
into three categories:

 (a) profitability
 (b) efficiency
 (c) financial health.
 Profitability ratios
 measure the ability of the company to generate
income from the use of its assets and invested
capital as well as control its cost.
 Gross profit ratio
 reports the peso value of the gross profit earned
for every peso of sales. We can infer the average
pricing policy from the gross profit margin.
 Operating income ratio
 expresses operating income as a percentage of
sales. It measures the percentage of profit earned
from each peso of sales in the company’s core
business operations .
 Net profit ratio
 relates the peso value of the net income earned to
every peso of sales. This shows how much profit
will go to the owner for every peso of sales
made. However, net income is profit for the
shareholders..
 Return on asset(ROA)
 measures the peso value of income generated by
employing the company’s assets. It is viewed as an
interest rate or a form of yield on asset investment.
The numerator of ROA is net income.
 There are also two acceptable denominators for ROA
– ending balance of total assets or average of total
assets.

 Average assets is computed as beginning balance +

ending balance divided by 2.
 Return on equity(ROE)
 measures the return (net income) generated by
the owner’s capital invested in the business.
Similar to ROA, the denominator of ROE may
also be total equity or average equity
PROFITABILITY
RATIO
 Operational efficiency ratio
 measures the ability of the company to utilize its
assets. Operational efficiency is measured based
on the company’s ability to generate sales from
the utilization of its assets, as a whole or
individually. -
 Asset turnover
 measures the peso value of sales generated for
every peso of the company’s assets. The higher
the turnover rate, the more efficient the company
is in using its assets.
 Fixed asset turnover
 is indicator of the efficiency of fixed assets in
generating sales.
 Inventory turnover
 is measured based on cost of goods sold and not
sales. As such both the numerator and
denominator of this ratio are measured at cost. It
is an indicator of how fast the company can sell
inventory.
 Days in inventory
 An alternative to inventory turnover .This
measures the number of days from acquisition to
sale.
 Accounts receivables turnover
 the measures the number of times the company
was able to collect on its average accounts
receivable during the year.
 days in accounts receivable
 An alternative to accounts receivable turnover .
This measures the company’s collection period
which is the number of days from sale to
collection.
OPERATIONAL
EFFICIENY
 Financial Health Ratio
 -look into the company’s solvency and liquidity
ratios.
 Solvency refers to the company’s capacity to pay
their long term liabilities.

 liquidity ratio intends to measure the company’s

ability to pay debts that are coming due (short
term debt).
 Debt ratio
 indicates the percentage of the company’s assets
that are financed by debt. A high debt to asset
ratio implies a high level of debt.
 Equity ratio
 indicates the percentage of the company’s assets
that are financed by capital. A high equity to asset
ratio implies a high level of capital
 Debt to equity ratio
 indicates the company’s reliance to debt or
liability as a source of financing relative to
equity. A high ratio suggests a high level of debt
that may result in high interest expense
 Interest coverage ratio
 measures the company’s ability to cover the
interest expense on its liability with its operating
income. Creditors prefer a high coverage ratio to
give them protection that interest due to them can
be paid.
 Current ratio
 is used to evaluate the company’s liquidity. It
seeks to measure whether there are sufficient
current assets to pay for current liabilities.
Creditors normally prefer a current ratio of 2.
 Quick ratio
 is a stricter measure of liquidity. It does not
consider all the current assets, only those that are
easier to liquidate such as cash and accounts
receivable that are referred to as quick assets.
Financial
Health
EXERCISE
S
 E NT
GNM
ASSI
 Accounting
Books - Journal
and Ledger
 The General Journal and Special
Journal
 Journal
is a chronological record (day-by-day) of business transactions.
It is called the book of original because it is the accounting
record in which financial transactions are first recorded.
General journal- simplest type of journal
Journalizing- process of recording a transaction
Recording all transactions in the general journal is not cost
effective and time consuming. To speed up and simplify the
recording process, most businesses make use of special journals.
Each special journal is designed to record a particular type of
transaction efficiently and quickly.
 Examples of special journals and
their use are the following:
 a. Cash Receipts Journal – is used to record all cash
that had been received. b. Cash Disbursements
Journal – is used to record all transactions involving
cash payments.
 c. Sales Journal (Sales on Account Journal) – is
used to record all sales on credit (on account)

Purchase Journal (Purchase on Account Journal) – is

used to record all purchases of inventory on credit (or
on account)
 The importance of using a journal
• The journal shows all information concerning a
particular transaction.
• The journal provides a chronological record of all
the financial events in the business over time. If we
want to know about a certain transactions of years
or months back, we can trace the said transactions
as long as we have the date of the said transaction.
The entries in the journal are arranged by date that
makes it necessary to locate a particular event.
 The Use of General Ledger
 A ledger is a means of accumulating in one place
all the information about changes in an asset,
liability, equity, income, and expense accounts
 general ledger is often called a T-Account
because of its resemblance to the letter T. A T-
Account is a simplified form of general ledger.
Chart of Accounts
 The normal balances of these accounts are listed below:
a. Asset Accounts – Debit Balance; however the normal balance of
a contra asset account is credit. In the above chart, the contra asset
accounts are:
 Allowance for Bad Debts
 Accumulated Depreciation (Accum. Deprn.) – Store Equipment
 Accum. Deprn. – Off Eqpt
 Accum. Deprn – Trans Eqpt
 Accum. Deprn – Building

b. Liability Accounts – Credit Balance

c. Equity Accounts – Owner’s, Capital account has a normal
balance on the credit side while the Owner’s, Withdrawal account
has a normal balance on the debit side.
d. Income – Credit Balance
e. Expense – Debit Balance
 Compound Journal Entry
An entry the involved two accounts only, one
debit and one credit is called a simple journal entry.
Some transactions, however, require more than two
accounts in journalizing. An entry that requires
three or more accounts is a compound entry
 To illustrate: Ariel Garden Supply Store acquire a land for P800,000.
Ariel paid P300,000 cash and issued a promissory note for the
balance. To record the above transaction using simple entry:
 (1) Land 300,000

Cash 300,000
To record purchased of land by paying cash
(2) Land 500,000
Note Payable 500,000
To record purchased of land by issuing promissory note

To record the above transactions using a compound entry:

Land 800,000
Cash 300,000
Notes Payable 500,000
To record purchased of land by paying cash and issuance
of a promissory note
EXERCISE
,
QUIZ
ASSIGNMENT
Basic Documents and
Transactions Related to
Bank Deposits
 Business usually maintain two types of account: (1)
savings account , and (2) checking or current account
 A. Savings Accounts

• These are intended to provide an incentive for the

depositor to save money.
• The depositor can make deposits and withdrawals
using the form provided by the bank.
• Banks usually pay an interest rate that is higher than a
checking account or a current account.
• Some savings accounts have a passbook, in which
transactions are logged in a small booklet that the
depositor keep
• Some savings accounts charge a fee if the balance falls
below a specified minimum
 B. Checking or Current Accounts
• Money held under a checking account can be
withdrawn through issuance of a check
• Banks usually allows numerous withdrawals and
unlimited deposit under this type of account.
• The interest rate for checking account is usually
lower as compared to a savings account.
• The account holder or depositor of a checking
account is normally provided at the end of the month a
bank statement showing all the deposits made, checks
paid by the bank, and the balance of the account.
• The depositor is given easy access to the funds as
compared to a savings account.
 Time deposit account
(or a certificate of deposit account) which is a
type of a savings account that is held for a fixed-
term and can be withdrawn only after the lapse of
the agreed period and by giving notice to the bank.
The account may be withdrawn also anytime
however the bank usually charges penalties. This
type of account yield high interest.
 ATM (Automated Teller Machine)
account wherein withdrawals can be
made through designated machines. This
is a 24 hour teller machine and the funds
can be withdrawn anytime. The
advantage of this account is that even if
the banks are closed, you can withdraw
your funds.
 In order to open a particular account, the bank
will require individuals certain documents such
as valid identification card and will ask you to
fill-up the forms prepared by the bank. Upon
approval of the application to open an account,
the bank will give the depositor his account
number
 Bank deposit and Withdrawal Slips
 A withdrawal slip and deposit slip are written
orders to the bank. These slips are used to take
out money or to put in money to the depositors
account.
Withdrawal Slip
The required information in the withdrawal slip are:
• Account Name - the name of the depositor
• Account Number – the unique identifier given by the bank for every
account maintained
• Date of the withdrawal
• Type of account - savings or current
• Currency
• Amount to be withdrawn - the amount that the depositor wishes to
withdraw from his account. The amounts in words and in figures are
indicated.
• Signature of the Depositor – this is the most important part in the
withdrawal slip. The signature is a proof that the depositor is authorizing
the bank to get money from his account. Usually, the bank compares the
signature in the withdrawal slip against the signature in the bank records
submitted during the opening of the account
 Deposit Slip
 The bank provides deposit slip that the depositor will fill up every time the
depositor will put in money to his account. The usually required information in a
deposit slip are:
 • Account Name – this is the complete name of the depositor that is reflected in
the records of the bank. If it has a pass book, the account name is indicated on
first page inside the passbook.
 • Account Number – this is a unique identifier of the account maintained by the
depositor.
 • Date of Deposit
 • Type of Account
 • Currency
 • Amount in words and in figures – the amount that the depositor wishes to put
into his account. The amount to be deposited maybe in form of cash or check. If
it is a cash deposit, the breakdown of the cash is usually listed in the deposit slip
if it is a check deposit, the details of the checks are indicated in the deposit slip,
for example: Issuing Bank, Address of the Issuing Bank, date of the check and
the amount.
 Identify and prepare check
(cheque)
 A check is a document that orders a bank to pay a specific
amount of money from a person's account to the person in
whose name the cheque has been issued. The person writing
the cheque, the drawer, has a transaction banking account
where his money is held. The drawer writes the various details
including the monetary amount, date, and a payee on the
cheque, and signs it, ordering his bank, known as the drawee,
to pay that person or company the amount of money stated.
Checks are a type of bill of exchange and were developed as a
way to make payments without the need to carry large
amounts of money. The check number is usually indicated in
the upper right portion of the check.
 The following are the parties involved in a
transaction that uses check as medium of
exchange:
 • Drawer, the person or entity who makes the
check
 • Payee, the recipient of the money
 • Drawee, the bank or other financial institution
where the cheque can be presented for payment.
 Cross Check

It is marked to specify an instruction about the way

it is to be redeemed. A common instruction is to
specify that it must be deposited directly into an
account of the payee. It is usually done by writing
two parallel lines on the upper left portion of the
check. A cross check cannot be encashed over the
counter by the payee. It should be deposited to the
payees account.
 Stale Check
 A cheque which a bank will not accept and
exchange for money or payment because it was
written more than a certain number of months
ago. In the Philippines a check becomes stale if it
exceed 6 months from the date of the check.
 Identify and understand the
contents of a bank statement
 At the end of every month, the bank furnishes a
statement to the depositor showing the movement
of the account. It contain all the withdrawals,
deposits and balance of your account after every
transaction. It may also indicate bank charges
that were deducted by the bank automatically.
Also, interest earned by the account is likewise
reflected.
 The date column indicate the date the transaction was made. The check number indicates the
details of the check paid by the bank. The transaction code is normally a bank code for the
transactions. The Debit column represents all charges or deduction made by the bank to your
account. The Credit column represents the deposits or additions to your account that was
made by the bank. The Balance column is the running balance after considering the effect of
the transaction to your account.
 Samples of Debit transaction
 • Bank service charge - monthly fee charged by the bank
for its services (Ex. cost of printing checks writing funds
to other locations and other fees)
 • NSF - (Not Sufficient Fund) – Banks also use a debit
memorandum when a deposited check from a customer
“bounces” because of insufficient funds.
Nowadays bank refer to this as DAIF (Drawn Against
Insufficient Fund) or DAUD (Drawn Against Uncleared
Deposits)

Samples of Credit transactions

• Collection of cash proceeds from notes receivables. •
Interest income earned by the deposit.
SEATWORK

WITHDRAWAL AND
DEPOSIT SLIP

CHEQUE
Basic Reconciliation
Statement
 Nature of Bank Reconciliation
Statement
 It is normal for a company's bank balance as per
accounting records to differ from the balance as
per bank statement. The difference between these
figures is the reasons why companies prepare a
bank reconciliation statement.
 Bank reconciliation statement is a report which
compares the bank balance as per company's
accounting records with the balance stated in the
bank statement.
 The two common causes of the
discrepancy in figures are:
• Time lags that prevent one of the parties (company or the bank) from
recording the transaction in the same period as the other party. Example: A
bank statement that ends January 30, 2015 and then the company were able
to collect cash of P20,000 at 5:00 PM. Bank usually closes at 3:00 PM
because of this, the cash collected will not be reflected in the bank as
deposit but it is however recorded in accounting records of the company.

• Errors by either party in recording transactions Example: A check was

issued to Meralco by the company amounting to P1000. The company
recorded this as P100. When the check was presented, the bank paid
Meralco P1,000. In the records of the company it was P100 while in the
records of the bank it’s P1,000. There is in this case an error that will cause
the difference between the company’s records and the bank records.
 The importance of Bank
Reconciliations are as follows:
• Preparation of bank reconciliation helps in the identification of
errors in the accounting records of the company or the bank.

• Cash is the most vulnerable asset of an entity. Bank

reconciliations provide the necessary control mechanism to help
protect the valuable resource through uncovering irregularities
such as unauthorized bank withdrawals. However, in order for
the control process to work effectively, it is necessary to
segregate the duties of persons responsible for accounting and
authorizing of bank transactions and those responsible for
preparing and monitoring bank reconciliation statements.
 • If the bank balance appearing in the accounting
records can be confirmed to be correct by
comparing it with the bank statement balance, it
provides added comfort that the bank transactions
have been recorded correctly in the company
records.
 • Monthly preparation of bank reconciliation
assists in the regular monitoring of cash flows of
a business.
 There three methods of preparing bank
reconciliation statement, namely:
 a. Adjusted Method wherein the balances per
bank and per book are separately determined.
 b. Book to Bank Method wherein the book
balance is adjusted to agree with the bank
balance.
 c. Bank to Book Method wherein the bank
balance is adjusted to agree with book balance.
The key terms to be aware of when
dealing with a bank reconciliation are:

• Deposits in transit are amounts already received

and recorded by the company, but are not yet
recorded by the bank.
 A deposit in transit is on the company's books, but it isn't
on the bank statement.
• Outstanding checks are checks that have been written and
recorded in the company's Cash account but have not yet
cleared the bank account or presented to the bank by the
payee. Checks written during the last few days of the month
plus a few older checks are likely to be among the outstanding
checks.

Because all checks that have been written are immediately

recorded in the company's Cash account, there is no need to
adjust the company's records for the outstanding checks.
However, the outstanding checks have not yet reached the
bank and the bank statement. Therefore, outstanding checks
are listed on the bank reconciliation as a decrease in the
balance per bank.
 • Bank errors are mistakes made by the bank.
Bank errors could include the bank recording an
incorrect amount, entering an amount that does
not belong on a company's bank statement, or
omitting an amount from a company's bank
statement.

The company should notify the bank of its errors.

Depending on the error, the correction could
increase or decrease the balance shown on the bank
statement.
 • Bank service charges are fees deducted from the bank statement for
the bank's processing of the checking account activity Examples: -
accepting deposits, - posting checks, - mailing the bank statement,

 Other types of bank service charges include the fee charged when a
company overdraws its checking account and the bank fee for
processing a stop payment order on a company's check.

 The bank might deduct these charges or fees on the bank statement
without notifying the company. When that occurs, the company
usually learns of the amounts only after receiving its bank statement.

 Because the bank service charges have already been deducted on the
bank statement, there is no adjustment to the balance per bank.
However, the service charges will have to be entered as an adjustment
to the company's books. The company's Cash account will need to be
decreased by the amount of the service charges.
 NSF check is a check that was not honored by the bank of the person
or company writing the check because that account did not have a
sufficient balance. As a result, the check is returned without being
honored or paid.

 NSF is the acronym for not sufficient funds. When the NSF check
comes back to the bank in which it was deposited, the bank will
decrease the checking account of the company that had deposited the
check. The amount charged will be the amount of the check plus a
bank fee.

 Because the NSF check and the related bank fee have already been
deducted on the bank statement, there is no need to adjust the
balance per the bank. However, if the company has not yet decreased
its Cash account balance for the returned check and the bank fee, the
company must decrease the balance per books in order to reconcile.
 Check printing charges occur when a company
arranges for its bank to handle the reordering of
its checks. The cost of the printed checks will
automatically be deducted from the company's
checking account.

 Because the check printing charges have already

been deducted on the bank statement, there is no
adjustment to the balance per bank. However, the
check printing charges need to be an adjustment
on the company's books. They will be a
deduction to the company's Cash account.
 Interest earned will appear on the bank statement when a bank gives a
company interest on its account balances. The amount is added to the
checking account balance and is automatically on the bank statement. Hence
there is no need to adjust the balance per the bank statement. However, the
amount of interest earned will increase the balance in the company's Cash
account on its books.

 • Notes Receivable are assets of a company. When notes come due, the
company might ask its bank to collect the notes receivable. For this service
the bank will charge a fee. The bank will increase the company's checking
account for the amount it collected (principal and interest) and will decrease
the account by the collection fee it charges. Since these amounts are already
on the bank statement, the company must be certain that the amounts appear
on the company's books in its Cash account.

 • Errors in the company's Cash account result from the company entering an
incorrect amount, entering a transaction that does not belong in the account,
or omitting a transaction that should be in the account. Since the company
made these errors, the correction of the error will be either an increase or a
decrease to the balance in the Cash account on the company's books.
 The Bank Reconciliation Process
 Step 1. Adjusting the Balance per Bank The first
step is to adjust the balance on the bank
statement to the true, adjusted, or corrected
balance.
The items necessary for this step are listed in the
following schedule:
 Step 2. Adjusting the Balance per
Books
 The second step of the bank reconciliation is to
adjust the balance in the company's Cash account
so that it is the true, adjusted, or corrected
balance.
Examples of the items involved are shown in the
following schedule:
 Step 3. Comparing the Adjusted
Balances
 After adjusting the balance per bank (Step 1) and
after adjusting the balance per books (Step 2), the
two adjusted amounts should be equal. If they are
not equal, you must repeat the process until the
balances are identical. The balances should be the
true, correct amount of cash as of the date of the
bank reconciliation. The adjusted cash balance
will appear as the Cash in Bank in the Statement
of Financial Position (Balance Sheet)
Practice Set
 Identify whether the following independent
transaction is a book or a bank reconciling. In
addition, determine the amount of the error and
state whether the amount will be added or
deducted in the preparation of the bank
reconciliation(use adjusted method):

 1. Eagle Repairs received P1,500 from Jane. The

bookkeeper recorded the amount as P500.
Answer: Book. P1,000 will be added to
the books.
 Nation Bank collected from the customer
of Eagle the sum of P5,000 representing
payment of the said customer to Eagle.
No entry was made in the books of
Eagle.

Answer: Book. P5,000 will be

added to the books.
 The bank teller deducted CK 123 for P3,500
from the account of Eagle. The said check was
issued by Eagles Company a different depositor
of the bank.

 Answer: Bank. P3,500 will be added to bank records. Hint:

The teller had deducted the amount to the account of eagle
which should not be, thus the amount is returned or added.
 The bookkeeper of Eagle recorded Check
No. 345 in the Cash Disbursement
Journal as P5,205. The correct amount of
the check was P5,250.

Answer: Book. P45 will be deducted in the book records.

The bookkeeper should have deducted P5,250 deductions to
cash however he deducted P5,205 only, thus the difference
should be deducted.
 The deposits of Eagle earned interest of
P100 for the month. Eagle does not have
knowledge of interest earned until it
receives the bank statement.

Answer: Book. P100 is added to the book

records. Interest income will increase the cash in
bank of Eagle.
 Practice Set 4

 Item 1 The bank statement for August 2014 shows an ending balance of
Php3,490.

 Item 2 On August 31 the bank statement shows charges of Php35 for the service
charge for maintaining the checking account.

 Item 3 On August 28 the bank statement shows a return item of Php100 plus a
related bank fee of Php10. The 134 Teacher Tips: Follow the procedure as
illustrated in the lecture/discussion. return item is a customer's check that was
returned because of insufficient funds.

 Item 4 The bank statement shows a charge of Php80 for check printing on
August 20.

 Item 5 The bank statement shows that Php8 was added to the checking
account on August 31 for interest earned by the company during the month
of August.
 Item 6 The bank statement shows that a note receivable of Php1,000 was collected by the
bank on August 29 and was deposited into the company's account. On the same day, the
bank withdrew Php40 from the company's account as a fee for collecting the note
receivable.

 Item 7 The company's Cash account at the end of August shows a balance of Php967.

 Item 8 During the month of August the company wrote checks totaling more than
Php50,000. As of August 31 Php3,021 of the checks written in August had not yet cleared
the bank and Php200 of checks written in June had not yet cleared the bank.

 Item 9 The Php1,450 of cash received by the company on August 31 was recorded on the
company's books as of August 31. However, the Php1,450 of cash receipts was deposited at
the bank on the morning of September 1.

 Item 10 On August 29 the company's Cash account shows cash sales of Php145. The bank
statement shows the amount deposited was actually Php154. The company reviewed the
transactions and found that Php154 was the correct amount.


Income and
Business Taxation
 Principles of Taxation
 • Governing tax law in the Philippines is the
National Internal Revenue Code of 1997. The
Bureau of Internal Revenue (BIR) is the primary
implementing agency of this law.

 • Taxation is the process by which the government

collects revenue in order to pay for its expenses.

 • Income tax is defined as the tax on the net

income or the entire income realized in one
taxable year.
 • Who are required to pay income tax in the Philippines? (Section 23 of
the National Internal Revenue Code [NIRC] of 1997)

 A citizen of the Philippines, living in the Philippines, is taxable on all

income earned inside and outside the Philippines;

 - A non-resident citizen is taxable only on income earned in the

Philippines; - An OFW is taxable only on income earned in the
Philippines.

 A foreigner living in the Philippines is taxable only on income earned in

the Philippines.

 - A domestic corporation is taxable on all income derived from sources

inside and outside the Philippines.

 - A foreign corporation is taxable only on the income derived inside the

Philippines.
 List of sources of gross income: (NIRC 1997 Chapter 6
Section 32 A)
 • Compensation for services in whatever form paid, including, but not limited to fees,
salaries, wages, commissions, and similar items

 • Gross income derived from the conduct of trade or business or the exercise of a profession

 • Gains derived from dealings in property; (Note: subject to 6% capital gains tax for
individuals and for corporation if land and building is not used in business)

 • Interests; (Note: generally subject to 20% final withholding tax)

 • Rents

 • Royalties; (Note: generally subject to 20% final withholding tax,10% if from books and
literary works)
 • Dividends; (Note: generally subject to 10% final
withholding tax for individuals, tax exempt for corporation)

 • Annuities

 • Prizes and winnings; (Note: generally subject to 20% final

withholding tax, except those that are tax exempt based on
specific criteria in the law)
 • Pensions
 • Partner's distributive share from the net income of the
general professional partnership.
 Compensation Income

 • Employed individuals that earn compensation

income pay their income taxes monthly.
Employers withhold the income tax of their
employees from their monthly gross income and
remit these sums to the BIR.

 •Philippine individual income tax is progressive.

The tax rate increases as the tax base increases
which means that tax payers with more capacity
to pay will pay more taxes.
 • All individual taxpayers are granted a personal exemption of P
50,000. Additional exemptions of ₱ 25,000 are given for each qualified
dependent but only up to four dependents. For husband and wives with
children, only one spouse can claim the additional exemption. The
husband is deemed head of the family and will claim the deduction
unless he explicitly waves his right in favor of his wife.

 • Withholding income tax for employees:

 - Employers are required by law to withhold income tax dues from their
employees’ salary.
 - It is implemented because employees might not have sufficient cash
to pay for their income tax dues if aggregated to a one time annual
payment.
 - The withholding tax deduction is computed based on the employee’s
gross compensation (net of mandatory contributions to SSS or GSIS,
Philhealth and Pag-ibig Fund), tax status, timing of compensation
payments and using the published BIR withholding tax table.
 Income tax is computed at the end of the year based on all
compensation income derived during the year.

 - Taxable income is computed after deducting personal and

additional exemptions.

 - Applicable tax rate is applied on the taxable income to get the tax
due. - The total income tax withheld by the employer is deducted
from the tax due to get remaining tax liability by the employee.

 • Taxpayers who derive their income solely from compensation

are required to file BIR Form 1700 as their income tax returns.
However, to give relief to these taxpayers, the employee may
present BIR Form 2316 as their income tax return. BIR Form 2316
is a statement issued by the employer and signed by the employee
but not filed with the BIR. This is referred to as substituted filing.
 Business Income

 • The tax payments of a business organized as a

sole proprietorship are made in the name of its
owner. The owner is considered an individual
taxpayer who derived income from business. He is
required to file BIR Form 1701.

 • Businesses may settle their income tax liabilities

and submit their income tax returns (tax form) to
the government three months and fifteen days from
the close of the year. For a business that follows a
calendar year, the date of settlement is April 15.
 Some businesses pay income tax on a quarterly
basis based on their quarter-end income.
Quarterly payments are due sixty days following
the close of the first three quarters of the year.

 - When the tax due is in excess of ₱ 2,000, the

individual taxpayer may elect to pay the tax in
two equal installments. The first installment shall
be paid at the time the return is filed and the
second installment is paid on or before July 15
following the close of the calendar year.
 • Two approaches for the computation of income tax for the
business:

 - Itemized deduction. Use the itemized expenses in the income

statement. The business should have a complete set of
accounting books and supporting receipts for the deductions
that were itemized on the tax form.

 - Optional standard deduction scheme. Deductions are up to a

maximum of 40% of “gross receipts”. “Gross receipts” is equal
to net sales plus other taxable income. This means that the
business taxable income is equivalent to 60% of gross receipts.
 • “Mixed Income Earner” is a compensation-earner who at the
same time is engaged in business or practice of profession. A
taxpayer deriving mixed income will also use BIR Form 1701.
 Compensation Income:

 Gross compensation (salary and other bonuses)

 Less: Statutory contributions (SSS or GSIS,
PhilHealth and Pag-ibig Fund) Gross compensation,
net of statutory payments Less: 13th month pay and
other bonuses that are exempted from income tax
 = Gross taxable compensation income
 Less: Personal ( P 50,000 per tax payer) and
additional deductions (P 25,000 per qualified
dependent, max of 4)
 = Net taxable compensation income
Example: Juan Dela Cruz generated annual compensation income of P615,000.
Statutory payments are as follows:
SSS – P 6,975.60; Philhealth - P 5,250;
Pag-ibig Contribution – P 1,200.
Total: P 13,425.60
Tax exempt 13th month pay and other bonuses – P 50,000.
(Note: Maximum tax exempt 13th month and other bonuses is
P 82,000 per Revenue Regulation 3-2015)
 From tax table, tax due for P491,574.40 is computed as follows:
 P50,000 + 30% of the excess over P 250,000 P 50,000 + 30%
(P491,574.40 - P250,000) = P122,472.32
 (Note: This is not the tax payable by the individual. Compare this with
the amount that the employer withheld. Any difference is the tax liability
payable on April 15. Generally, if the employer correctly withheld during
the year and there are no changes in the tax status and tax base during the
year, the amount withheld will be equal to the tax due. However, there
will be a difference if there are changes in the taxability of the tax payer
(single to married, changes in number of qualified dependents) and
change in tax base (i.e. increase in salary)